What Is Key Man Life Insurance and Why Might You Need It?
- Learn what key man life insurance is and find out why a business may wish to purchase it for certain employees. Get the facts you need to protect your business.
Succession planning helps ensure that a company can continue to function if a key person exits their role, retires or dies. Key man life insurance can play an important role in succession planning. Learning what key man insurance is and why it's beneficial can help you determine if your business needs the financial protection it provides.
What Is Key Man Life Insurance?
Key man insurance is a life insurance policy that a company purchases for a critically ill employee. If that person passes away, the policy pays a death benefit directly to the company. Business life insurance, key person insurance and key woman insurance are other names for key man life insurance.
How Does Key Man Life Insurance Work?
A key man life insurance policy normally involves the following steps:
- A company applies for a policy, and the key person signs the application.
- The key person completes a medical questionnaire and may have to undergo a life insurance physical exam.
- The life insurance company underwriters determine whether to approve the application.
- Any approved policies take effect, and the company begins paying a monthly premium.
- If the key person dies, the company files a claim to receive the death benefit.
Who Is a Key Person?
A key person can be anyone who performs duties that are essential to the daily operations of a small business. For a small business, the owner is usually a key person because they are likely to perform many important tasks like bookkeeping and managing employees. The U.S. Small Business Administration reports that owner death often contributes to the closure of small businesses. A survey conducted in 2015 found that 3.1% of all small-business closures were due at least in part to the death of the owner, pointing to the importance of having key man life insurance for small-business owners.
A business may also purchase key person insurance for the founders of the company or any employee who performs essential tasks, such as accounting, payroll, product development or management.
Who Is the Owner of a Key Person Life Insurance Policy?
The business is the owner of a key person life insurance policy. Payouts from key life insurance go to the company that purchased the policy, and the business is responsible for paying the premiums.
Why Would a Business Need Key Man Insurance?
The purpose of key man life insurance is usually to keep a business afloat following the death of a vital employee. A business may need the proceeds from a key person life insurance policy to:
- Decrease the risk of lost profits due to lost sales or the cancellation of projects due to a key person's death
- Allow for changes in ownership, permitting shareholders or partners to buy the shares of the company owned by the deceased person
- Avoid default on business loans and other financial obligations and overall bankruptcy
What Can a Business Do With a Death Benefit From Key Person Insurance?
Businesses may use the proceeds of key person insurance in many ways. The money can help with:
- Paying bills and other expenses
- Recruiting, hiring and paying temporary or permanent employees
- Funding payroll
- Increasing cash flow
In some cases, key man life insurance may be purchased to allow a business to settle its obligations and close in the event of the death of the owner by providing money to:
- Settle all debts
- Pay shareholders and investors
- Provide severance packages to employees
- Cover the cost of other expenses that arise in the process of closing
How Much Does Key Person Life Insurance Cost?
The price of key man life insurance depends on:
- Size of the death benefit. The larger the death benefit, the more expensive the monthly premium will be.
- Type of insurance. Generally, term life insurance policies that last for a certain time period are less expensive than permanent insurance that remains in effect until a person dies.
- Age of the key person. Life insurance premiums are usually higher for older adults.
- Health of the key person. Insurance companies may use a questionnaire, physical exam or information obtained from medical records to assess a person's likelihood of dying due to natural causes.
- Whether the key person smokes, engages in risky behaviors or recreational activities or has a dangerous job. Insurance companies may look at social media accounts, run background checks and consult public records to examine the key person's lifestyle. Some risky behaviors such as smoking or regularly drinking alcohol may result in increased premiums. Others may lead to a complete denial of coverage.